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Dfi 403: Real Estate Finance And Investments Question Paper
Dfi 403: Real Estate Finance And Investments
Course:Real Estate Finance And Investments
Institution: University Of Nairobi question papers
Exam Year:2015
Question One
A group of investors would like to purchase a property worth Sh. 140,000,000. They are considering two financing alternatives. The first is a 95%, 30-year, fixed-rate mortgage at 5.75% interest. With this mortgage, the lender will require mortgage insurance which will cost Sh. 94,000 per month (this amount will be added to the monthly principal and interest payment). The mortgage insurance will be cancelled after 13 years, so that the added payment of Sh. 94,000 per month will not be required during years 14-30 of the loan. The lender will charge 1 point in conjunction with this loan. The second option combines an 80%, 30-year, fixed-rate mortgage at 5.50% interest with a Sh. 22,000,000 mortgage insurance loan amortized over 10 years with a 7.25% interest rate. Total fees associated with this financing will be Sh. 2,330,000. The investors’ holding period is at least 30 years.
Required
Which of the two alternatives would you recommend? Explain.
Question Two
Moses presently owns the Marine Tower office building, which is 20 years old, and is considering renovating it. He purchased the property two years ago for Kshs800,000 and financed it with a 20-year, 75 percent loan at 10 percent interest (monthly payments). Of the Kshs800,000, the appraiser indicated that the land was worth Kshs200,000 and the building Kshs600,000. Moses has been using straight-line depreciation over 39 years (1/39 per year for simplicity). At the present time Marine Tower is producing Kshs90,000 in NOI, and the NOI and property value are expected to increase 2 percent per year. The current market value of the property is Kshs820,000. Moses estimates that if the Marine Tower office building is renovated at a cost of Kshs200,000, NOI will be about 20 percent higher next year (Kshs108,000 versus Kshs90,000) due to higher rents and lower expenses. He also expects that with the renovation the NOI will increase 3 percent per year instead of 2 percent. Furthermore, Moses believes that after five years, a new investor will purchase the Marine Tower office building at a price based on capitalizing the projected NOI six years from now at a 10 percent capitalization rate. Selling costs would be 6 percent of the sale price. Moses is in the 28 percent tax bracket and expects to continue to be in that bracket. He also would not be subject to any passive activity loss limitations. If Moses does the renovation, he believes he could obtain a new loan at an 11 percent interest rate and a 20-year loan term (monthly payments).
Required
a) Assume that if Moses does the renovation, he will be able to obtain a new loan that is equal to the balance of the existing loan plus 75 percent of the renovation costs. What is the incremental return (ATIRRe) for doing the renovation versus not doing the renovation? Assume a five-year holding period.
b) What advice would you give Moses? (20 marks)
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